The Fed Blog

Wednesday, April 11, 2012

The Euro Mess Again

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The Bond Vigilantes are restless in Europe. They are threatening to do to the euro zone what the barbarians did to the Roman Empire. It could get uglier in Europe if the Bond Vigilantes decide to take no prisoners. They seem to be running out of patience with Europeans who refuse to accept that their social welfare state is bankrupt.

Of course, the Bond Vigilantes weren’t very vigilant when they financed European government deficits all too willingly and too easily following the introduction of the euro at the beginning of 1999. Yields on the bonds of the most reckless governments quickly fell toward German yields and remained there until the Greeks admitted in late 2009 that they had fibbed about how much they really owed.

Now the Bond Vigilantes are losing their interest in providing more funds to reckless European governments. That was obvious when Spanish and Italian bond yields rose above 7% last summer. Those yields plunged down to 5% early this year after the ECB flooded the European banking system with liquidity through the LTRO. However, also earlier this year, the Bond Vigilantes were forced to accept a huge "voluntary" haircut on their Greek bonds.

The big backup in Spanish bond yields in recent days suggests that the LTRO liquidity is already drying up, or at least it certainly isn’t holding down Spanish yields. Spain’s 10-year yield jumped more than one percentage point since March 2, when the government announced that Spain will miss its 2012 budget-deficit goal approved by the EU. It rose 20bps just yesterday to 5.94% despite the government’s efforts to calm the Bond Vigilantes with €10 billion of budget cuts in education and health. This morning, it is down to 5.79%. Spain may be the fourth euro member to need a bailout.

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ABOUT: Dr. Ed Yardeni is the President and Chief Investment Strategist of Yardeni Research, Inc., a provider of independent investment strategy and economics research. This blog highlights excerpts from our research service, which is designed for investment and business professionals.